Economic Development

Across the United States, state and local governments are locked in a constant competition to attract and retain businesses. Public subsidies, in the form of grants, loans, tax incentives, and other blandishments, have become a large part of the “development toolbox,” as termed by former Pennsylvania Department of Community and Economic Development Secretary Sam McCullough, that officials use to win these bidding contests.

Development officials often argue that a state that refuses to offer publicly funded inducements will unfairly harm its chances to attract businesses. However, it is highly questionable as to whether or not being the high bidder in the incentive contest is a “winning” proposition for the governments taking part.

No Real Winners

The economic development subsidy contest is a “zero-sum game” at best for state and local governments, especially when one looks at the broader economic landscape. For example, using taxpayer-funded incentives to move a firm from one area of a state to another has no effect on that state’s economic vitality. And while the states and communities that succeed in attracting companies do gain if those companies would create jobs somewhere in any case, those benefits are usually not placed in their proper context.

The governments touting incentives as having created jobs and attracted businesses very rarely look at the other side of the equation: the fact that they have also, at times, lost out when attempting to use subsidies and other inducements to lure companies. A look at this larger, more complete picture would yield a more realistic, less rosy assessment of whether or not an incentive-based development strategy is a wise one for governments seeking economic expansion. In addition, governments do not usually conduct a rigorous analysis of whether or not the development that does occur would have happened in the absence of their intervention.

Robbing Peter to Pay Paul

Studies do in fact show that incentives are generally not the deciding factor in business location decisions. This means that many of the scarce tax dollars that are supposedly helping wavering companies make up their minds about where to locate simply allow private investors to make an even greater return on investments that they would have undertaken in any case. By offering subsidies to companies that do not “need” them, states feed a vicious cycle of taxpayer-funded handouts.

Still, development officials often respond to this argument by claiming that they have no other choice but to offer subsidies—especially in states, like Pennsylvania, that have generally poor overall business climates characterized by high business taxes.

However, an approach that forces businesses already operating in a given state to pay, through their taxes, for the incentive packages used to attract companies from out of state only serves to move that state’s business climate from bad to worse. A far superior approach is to lower the tax burden for all businesses and to forgo spending state tax dollars to enrich a favored few (some of which are likely competitors to existing firms).

Big Spenders Aren’t Big Winners

Over the past eight years, Pennsylvania has pursued a strategy of enacting incremental business tax reductions while continuing to generously fund economic development programs. Given Pennsylvania’s still-sluggish job, income and population growth during those years, it is not difficult to imagine that had the dollars spent on economic development by state government been spent on other activities—such as general infrastructure improvements that can be used by all businesses—or left in the private sector through further tax reductions, its economic fortunes would have been far brighter. In fact, the available evidence suggests that states that spend less, not more, on economic development subsidies grow faster than those states, like Pennsylvania, that spend more on incentive programs.

According to data developed by the Pennsylvania Legislative Budget and Finance Committee from survey data collected by the National Association of State Development Agencies, Pennsylvania ranked fifth among the 47 states for which data were presented in terms of per capita state economic development funding in FY 1997-98. The top ten states in the survey had an average state per capita funding figure of $22.66. At the same time, the ten states with the lowest per capita state economic development funding figures had an average per capita figure of $1.73.

If the conventional view of the effect of state economic development spending is correct, it would be expected that in the years following the expenditure, the states that spent more heavily in this area would attract people, jobs and income faster than the states that failed to “invest” as many public dollars in economic development. The numbers, however, tell a different story.

Between 1997 and 2001, the ten states with the highest per capita state economic development funding collectively had a population growth rate of 3.6 percent, an employment growth rate of 3.3 percent, and a personal income growth rate of 23 percent.

At the same time, the ten states with the lowest per capita state economic development funding collectively had a population growth rate of 8.3 percent, an employment growth rate of 7.8 percent, and a personal income growth rate of 30.6 percent. In sum:

  • The personal income growth rate was 33 percent higher in the low-spending states than in the high-spending states.
  • The population growth rate was 130.5 percent higher in the low-spending states than in the high-spending states.
  • The employment growth rate was 136.4 percent higher in the low-spending states than in the high-spending states.

Low-Tax States Outperform High-Tax States

Conversely,the states that have done the best job of controlling taxes have far outperformed those that have not. During the 1990s, Pennsylvania ranked as one of the 10 worst states in terms of the growth of taxes relative to its citizens’ personal income.

A comparison of the 1990-2000 economic performance of Pennsylvania and the nine other states with the highest tax-income growth ratios with the 10 states with the lowest tax-income growth ratios shows that the low-tax states had dramatic advantages in employment, population, and gross state product growth. Specifically, 1990-2000 population, employment, and real GSP growth rates in low tax-to-income states were a respective 87.6, 45.8, and 72.1 percent higher than those in high tax-to-income states.

In fact, the success of the low tax-to-income states was so dramatic that by 2000, they had erased the advantages held by the high tax-to-income states in population, employment, and real GSP in 1990. Over the past decade, people clearly “voted with their feet,” and businesses and investors with their dollars, against the high-tax Keystone State.

Conclusion: What State Government’s Role Should Be

It is important to note that a plethora of factors other than state government policies influence statewide economic performance—and there are a few areas in which a limited, but active state government can have a positive impact.

For example, redirecting state economic development resources toward infrastructure that can be used by all businesses—such as road, highway and street improvements, enhanced water and sewer facilities, and selected communications infrastructure—can be a productive role for government activity.

Government can also take an active role in reviewing and streamlining the regulatory process in order to remove barriers to entrepreneurial activity. Doing so will spur small business growth, which produces the vast majority of new jobs in the United States as a whole and in Pennsylvania in particular.

Still, the results of the preceding comparison of the economic effects of various levels of state development expenditures are instructive in that whatever conclusions may be drawn from the data, the finding that states spending more on economic development are more successful economically than those that spend less is not among them.

Instead, freeing up more capital for private investors via even larger tax cuts and reduced state involvement in investment decisions, along with strict overall spending discipline, would likely accelerate the Commonwealth’s economic expansion.

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